Lower tax but stricter rules: what landlords should do next

Last week’s Budget may have been a damp squib for voters, but changes to the landlord tax system will have a long-lasting impact and force property investors to make a decision.

Chancellor Jeremy Hunt is to scrap the ‘furnished holiday lets’ (FHL) regime from April 2025 and reduce the capital gains tax (CGT) rate for property sales from next month. Combined, experts say the two changes provide further encouragement to landlords to either leave the market or professionalise their operations.

The FHL regime, whereby properties are let out on short-term deals, has played an important role in protecting the profits of landlords operating outside of a limited company. As mortgage interest relief has been withdrawn on residential buy-to-lets – relief is now 20 per cent rather than levied at the marginal tax rate – thousands of property investors have turned to holiday lets. If they meet certain conditions – such as ensuring the property is available to be let out for at least 105 days a year – investors enjoy full mortgage interest relief, more generous capital expenditure deductions and a capital gains tax (CGT) rate of just 10 per cent because the property qualifies as a business.

As such, there has been a surge in landlords shifting from residential to holiday lets, particularly in tourist hotspots, buoyed latterly by four summers of foreign travel disruption prompted by the pandemic and airline capacity issues. The National Residential Landlords Association (NRLA), a trade body, says a “significant number” of its members have moved over from residential to holiday let properties in the past eight years, while data from Hamptons, an estate agent, shows two in four holiday let investors also own buy-to-let properties, indicating a huge crossover between the two business lines.

Changes to CGT were cleverly tacked on to the removal of FHL benefits by Hunt. Investors who wanted to stop being residential landlords, but were reluctant to sell up and pay hefty capital gains charges, were the most likely to move to holiday lets. However, now the chancellor has cut the higher rate of property CGT from 28 per cent to 24 per cent. 

Karen Noye, a mortgage expert at Quilter, says the changes mean buy-to-let investors should consider whether they are getting value from their properties. “The reduction in CGT may be the tipping point for landlords who have been considering selling due to the less favourable tax position for buy-to-lets, increased interest rates, property running costs and changes in regulations,” she adds.

Go professional or go residential

The easiest option for either residential or holiday let landlords is to turn professional. However, this comes at a high price and requires scale in order to be effective. And, even with the property CGT rate cut, investors who have been in the game for a long time still face hefty bills if they wish to turn in this direction.

According to Hamptons, the average landlord CGT bill per property in the 2022-23 tax year was £21,260 if they were a higher-rate taxpayer, meaning a capital gain of around £88,000. Assuming a similar profit in 2024, the bill would drop to £20,400 if they were to pay a rate of 24 per cent instead of 28 per cent. Assuming an incorporated property business needs a minimum of three properties to be viable, that’s still more than £61,000 due in tax, plus other costs of incorporating such as accountancy fees and registering with Companies House, as well as higher mortgage rates for businesses compared with those charged to individual buy-to-let landlords.

But the benefits of being a limited business are there to see, too. Full mortgage interest relief, corporation tax on profits instead of income tax, the ability to take income as dividends and the ability to add partners as directors means that, depending on how many properties a landlord owns, the overall tax bill could reduce over the long term. 

Thousands of landlords have taken this decision, according to Hamptons. Last year another 50,000 buy-to-let businesses were incorporated, adding to the 48,500 in 2022 and 42,100 in 2023. The same has been seen in the holiday lets market, where the number of new businesses incorporated each year has nearly doubled from 1,300 in 2019 to 2,500 last year.

David Fell, analyst at Hamptons, says: “The number of new rental companies is already running 30 per cent higher this year versus last year, so incorporation continues to be the direction of travel for both holiday lets and traditional landlords. Aside from the growing potential tax advantages, it also offers some degree of certainty and stability with perhaps a little more protection from what’s been fairly frequent rule and tax changes since 2016.”

Data from the NRLA supports this. Before 2015, only one in 10 landlords bought a property via a company. Now one-third do so, although some operate ‘mixed’ portfolios due to the tax implications of selling a property to a business.

Landlords could alternatively abandon holiday lets and return to offering residential lets. As there will soon be no tax advantages for the former, plus the prospect of increasing regulation from local councils and growing resentment from local populations, the benefits of offering short-term lets are quickly fading.

This is what the chancellor suggested the scrapping of the FHL regime will do. In his Budget speech, Hunt said the FHL regime had created a “distortion”, meaning there were not “enough properties available for long-term rental by local people”. The Treasury’s sums suggest the removal of FHL perks and the lower CGT rate will raise £600mn more per year in revenue. So it’s more likely the chancellor expects an increase in property sales, albeit this could be to limited companies which then return the properties to long-term lets.

However, the residential letting market is far from easy. The Renters’ Reform Bill, which alongside many changes proposes more onerous rules on evictions, has thus far been parked by the Conservatives. But whoever is in Downing Street next year is likely to bring harsher regulations for landlords back to Parliament, and that is particularly the case if the Labour party is in government. Rules to ensure all rental properties are energy efficient, and have an energy performance certificate rating of 'C' or better, are also still stuck in the swamp of bureaucracy. But they remain likely to be in force by 2030, and potentially earlier under a Labour government.

The trade-offs from this move in terms of income are difficult to calculate and depend on the area. At face value, residential properties offer less rent but are more predictable. Holiday let income is susceptible to external factors including the weather and competition from foreign travel, and can have higher expenses such as ongoing management and marketing.

Fell says it is difficult to see how Hunt’s expectation for a shift back to residential lets will happen. “Rather, it will continue driving the rush to incorporation among current and prospective holiday let owners. That said, it will probably stem the flow of further longer-term landlords into the holiday let market,” he adds.

The NRLA disagrees and says it rarely made economic sense to sell a portfolio to your own limited company, as you need to find the cash to pay the capital gains bill. Someone exiting the market can use the sale proceeds to settle up with the tax office. The trade body’s policy director, Chris Norris, says the chancellor’s suggestion that it would boost the supply of long-term lets is “difficult to believe”.

He adds: “Replicating the rules imposed on residential landlords [on holiday lets] may prevent the movement from one market to the other. But there is no reason to believe landlords will bring properties back to the residential space. It is more likely investors will use the remaining year of the regime to take advantage of the preferential CGT rate and dispose of property.”

Is it time to sell?

Norris’s expectation looks logical. Landlords operating FHLs may be enticed by the lower CGT rate, and sell up before it expires next April. However, they will only qualify for 10 per cent relief on property price gains made while operating as an FHL and will pay the standard property CGT on the rest. Between April 2024, when the CGT rate cut comes in, and April 2025, when the FHL regime is scrapped, there is a window to take advantage of both.

However, Norris also says the residential CGT cut is misleading. “The reduction of the higher rate of CGT is undoubtedly welcome. However, Hunt failed to mention that his department reduced the CGT tax-free allowance from £12,300 in 2022-23 to only £3,000 for the next financial year. So, despite the cut, most selling from April will pay more than they would have previously.”

Only those with profits above £68,000 will see a lower tax bill as of April compared with if they had sold before April 2023, and even capital gains of £200,000 only bring a tax saving of £5,300.

Overall, the changes once again muddy the waters for property investors, already hit by a sea change in policy since 2015. The drive to professionalise is gaining momentum, and the last haven for DIY landlords will soon disappear. Paying some kind of CGT bills seems like a given.

Plenty will have had enough and see this as the final nail in an already well-studded coffin; further confirmation that the once-lucrative world of buy-to-let is no more. For those that want to professionalise, it’s important to take advantage of every allowance, and source mortgage deals in advance. For those who want to exit, professional landlord businesses buying in bulk is becoming more common. However, be wary of selling all your properties in one go, and losing out on your annual CGT exemptions.